Investment properties, such as rental apartments and commercial office space, generate steady income for the owners. Cash flow is the difference between rental income and the sum of mortgage and operating expenses. A well-managed investment property generates steady positive cash flow. It is almost like owning a high-quality stock that pays quarterly cash dividends or a bond that makes semiannual interest payments. Negative cash flow results when operating expenses and mortgage payments exceed rental income.
Instructions
1. Find the annual income for the investment property. If the property has a recent occupancy history, use the rental rates to estimate the maximum annual rental income assuming 100-percent occupancy. If you do not have access to the rental history, use the rental rates in comparable investment properties to estimate the rental income. Canadian real estate entrepreneur Scott McGillivray wrote in an August 2010 "Globe and Mail" article that he includes a minimum of five comparable rental properties because it leads to a more accurate estimate.
2. Adjust the annual income by making an allowance for vacancies and bad debts. Very few buildings have 100-percent occupancy and not all tenants pay their rent on time. Your local chamber of commerce or municipal office may have up-to-date information on average residential and commercial vacancies in your area. The U.S. Census Bureau also publishes quarterly and annual reports on vacancy rates by geographic area and property type.
3. Estimate the operating expenses. If you have the operating expense history for a property, you may adjust it by the annual inflation rate to estimate the expense for the current year. If not, itemize the key items and estimate the monthly or annual costs for each. These items include property taxes, insurance, security, landscaping, cleaning services, utilities, advertising and maintenance. You may ask owners of similar properties in the neighborhood for ballpark estimates of these operating expenses.
4. Determine the annual mortgage payments. Mortgage brokers or bank loan officers should be able to provide an estimate based on prevailing mortgage rates, and different combinations of down payments and mortgage amounts. You may also use one of several online mortgage calculators to estimate your mortgage payments.
5. Calculate the annual cash flow. It is equal to the adjusted annual income minus the sum of operating expenses and mortgage payments. Note that depreciation, which is the allocation of the cost of the property over its estimated useful life, has no impact on cash flow because it is a non-cash expense. However, depreciation does reduce your taxable income for the year.
